Rolls Royce shall be a ‘hold’ at the current levels as the recent rally and consolidation of the stock confirms the fact that the stock has overcome the negative impact of the change in accounting standards. We stated in our last article that the fresh positions can be built in Rolls Royce, in case the stock breaches the 687p and it did pierce 687p and continued to rally. However, lately the stock has been going through a consolidation and correction mode. Therefore, once the stock is done with its correction and consolidation, fresh longs can be initiated again.
The stock finished trading on the London stock exchange at 759p a share on 6th March, down by 0.07% compared to the previous close. Currently, the stock has been trading above its 20 day moving average (DMA), 50 DMA and 100 DMA of 740p, 701p and 703p respectively. The immediate support and resistance for the stock is at 740p and 788p respectively. In case the stock goes below 740p, then it may test the levels of 720p as well and in case of breakout above 787p, the next target for the stock could be 800p. Therefore, the traders need to keep a close eye on the respective levels and accordingly hedge or initiate fresh positions. In terms of technical analysis, the stock has been trading on an upward trend line which confirms bullishness of the stock in the short term.
Now let’s throw some light on the FY’16 results of the company. As per the management, the year 2016 has been an important year for the company as Rolls Royce went through the transformation. Despite the significant market and aerospace product transition challenges identified in 2015, the company has made operational progress and performed ahead of its expectations. The company’s FY’16 reported revenue was up by 9%, but the underlying profit before tax is down by 49%. However, the company’s free cash flows improved owing to working capital improvements.
Out of all the segments, revenue from the marine segment were down by 24% primarily because of weak offshore markets which impacts both OE and service revenues. The revenue from the nuclear segment is up by 11% year on year because of increased submarine work. Important information for the investors is that the value of sterling relative to the US dollar has fallen significantly, since the British referendum. As a result, the company has recognized a £4.4bn in-year non-cash mark-to-market valuation adjustment for its currency hedge book as part of its reported financing costs of (£4,677m) (2015: (£1,341 m). Although this transaction didn’t affect the company’s topline but it did affect the reported results of the company. The reported results of the company also included £671m charge for financial penalties from agreements with investigating authorities in connection with historic bribery and corruption involving intermediaries in a number of overseas markets. The company’s reported loss before tax was (£4,636m) (2015: £160m profit).
Based on the above discussion, the management guidance and our own estimates, we estimate Rolls Royce’s 2017 revenue will be £15.5 billion (£14.955 billion for fiscal 2016) and the operating profit will be £311 million (2016 operating profit was £44 million). Our estimates are conservative and assume 4% year-over-year growth in sales and a margin for earnings before interest and taxes (EBIT) of 2% please find below the earnings outlook of fiscal 2017:
We have assumed a conservative EV/sales multiple of 1.1x, which is at par the historical multiple of 1.2 x. Based on this ratio and estimated 2017 sales, we have calculated a stock price target of 840 pence.
The calculations are shown in the table below:
We set the Hold recommendation on Rolls Royce Plc. With 6 months to 12 months target price of 841p a share.